Anyone here trade options?

[FIRE'd@51]

Again, you only point out the negative aspects and ignore the positive. What happens when SPY rises by less than the put premium, or drops by less than the put premium? That's what happens the majority of the time.

Since we are pointing out things that help our arguments....what if the market was in a slow descent and spent an entire year where every single week it lost .25%. At the end of the year SPY would be down about -13%. Depending on the VIX, the naked puts would make around 39% or 200% on margin. Thats a ridiculous example, but there are several down years for the market that I studied that the naked puts would've made money. Variance is lower with this strategy.

I'm simply using your numbers to compare your results with B & H on a risk-adjusted basis.

Your statement that naked puts levered 5 to 1 will outperform SPY in a down market is incorrect. Currrently, ATM weekly puts have a premium of about 0.5%. If SPY drops just 1% over the next week, you lose 2.5% on your 5 to 1 levered naked puts, which is 1.5% worse than owning SPY unlevered.

I'm not quibbling with your strategy. I'm just trying to compare it to SPY on the proper risk-adjusted basis. BTW, didn't you say earlier in this thread, that the proper way to calculate returns is to use the notional amount in the denominator? After all this is your downside risk (less the premium), when you sell naked puts.

 

[utrecht]

I should have never mentioned the leverage aspect because it has you confused into thinking that I think I can make 5 times as much money trading the naked puts. I would never confuse myself into thinking that I can trade naked put positions that are 5 times larger than I can afford to trade in stock position. The risk would be ridiculous. Im not trying to compare 5-1 leveraged puts to owning SPY outright.

My research shows that the long term results are pretty much the same selling naked puts or just buying the stock, but since this is a trading account there are many advantages to selling the puts instead.

If you forget about the 5-1 leverage and compare 10 SPY contracts to 1000 shares of SPY, the puts will lose less money when SPY is down, will make more money when SPY is flat to slightly up and will make less money when SPY is up sharply. Over the long term, the results are basically the same but the naked puts have less variance. Yes or No?

If the market starts dropping, the VIX is going to rise and the weekly puts will have a much higher premium than the current ~0.5%. And again, forget about the 5-1 leverage. It is not possible for the naked puts NOT to outperform SPY in a down market when comparing apples to apples.

Asking about a flash crash is a bit ridiculous. I could ask you what would happen to your buy and hold strategy if a hacker hacks your account and removes all traces of your money. The flash crash was a glitch that will probably never happen again, and even if it does what I see happening is this: the stock drops a sickening amount, the puts get assigned and I have a ton of stock in my account. 5 minutes later the stock is back to its correct price and I have suffered no loss. The next day I have to sell it to prevent a margin call. This assumes that the SEC doesn't bust the entire trade and make this point mute.

 

[utrecht]

Clifp and Nords,

With regards to how long doing this stuff takes, I happen to really enjoy it (other than doing the taxes). So saying it just takes too much time is like saying watching football all day long on Sunday is a waste of time. Not if you love football its not. I would be happier if the market was only closed one day per week instead of two. If it ever becomes like work I will stop trading. I used to play what I would call semi pro poker. I played 10-15 hours per week and did very well. Eventually I started to think of it as a part time job and it got monotonous and I quit playing for the most part.

 

[ERD50]

It is not possible for the naked puts NOT to outperform SPY in a down market when comparing apples to apples.

Not so sure about that. You are not collecting divs, so the premiums have to overcome that. Plus, you can get whip-sawed. If SPY drops more than your premium, you have a loss (as does the SPY B&H). If SPY recovers to within 1% the next week, the B&H has a 1% loss, you may have more than that if the next week's premium isn't sufficient to cover the loss. Markets rarely go straight up/down in a linear fashion, they bump/bounce along their way.

And then over the long run, that has to exceed the opportunity cost of a rising market (plus the divs I mentioned).

Not saying it won't work, but I do think that 'not possible' is over-stating it, and not really very relevant since markets go up and down.

-ERD50

 

[FIRE'd@51]

Im not trying to compare 5-1 leveraged puts to owning SPY outright.

But that's exactly what you did in post #190. From that post:

It takes about $27500 in margin for every 10 contracts. Over these 52 weeks, Ive made $21040 for every 10 contracts sold. Thats a return on margin of 76.5%. SPY returned 15.9% (not counting dividends) over these 52 weeks.

All I did in post #192 was point out that without margin the naked put strategy underperformed SPY over this particular time period.

So far as the lower variance with the naked put strategy goes, with an asymmetric return distribution, I'm not sure variance is even an appropriate measurement of risk. With the naked put strategy, in any given week, all the variance is on the downside. IMO, this is bad variance. If I just hold SPY, I have equal amounts of downside (bad) and upside (good) variance.

 

[utrecht]

As I mentioned already, I probably should not have thrown the return on margin numbers out there in the first place because it clouds the apples to apples comparison.

As to variance, naked puts make less money on the upside, lose less money on the downside and have a higher percentage of weeks that have a profit. That is basically the definition of less variance. If these conditions are true and the long term total profit is about the same, then I don't see how the naked puts are not superior for a trader (other than the time a person needs to spend making the transactions).

What makes this a much better strategy for me though is the fact that I essentially can invest on margin without borrowing any money and having to pay interest. Getting away from the mechanical aspect of the strategy and doing some market timing, I can and have sold 10-30 contracts in certain weeks when I didn't have enough cash to buy 1000-3000 shares of SPY. This is after all a trading account, not a long term buy and hold account like my other IRAs and 401ks.

This thread started out as a comparison of B&H SPY to selling naked SPY puts. I thought the naked puts would outperform on a percentage basis and I learned that I was wrong. They are more or less the same. But I did learn that selling puts has the other advantages that I talked about. I do appreciate the feedback Ive gotten. Its made me think twice and then rethink again, every aspect of the strategy.

For anyone interested, during the 52 weeks the avg VIX was 24.0 and the avg put premium was 1.03%.

 

[clifp]

Since I got an email question on this subject, I thought I add a few more thoughts on risk and practicality.

If we look an aggressive retirement portfolio of ~$1 million, consisting of 5,000 SPY (~700K), 100K each in small cap, bonds, and international. Now compare this to the same portfolio in an IRA of ~700K cash but instead of holding 5,000 SPY we trade 50 SPY cash secured puts each week. I believe what utrecht is saying and both backtesting and common sense seem to bear out is that in an bull market this will lag B&H, but in a bear market it will outperform.

Overall this seem like Alpha for a retiree because what we are all struggling to do is capture the superior returns of stocks without having to suffer through their higher volatility as long as the total return is the same it is win as Utrecht says.

The other advantage of making these trades from an IRA is it is easier since you don't have to worry tax reporting and it is far more tax efficient than employing this strategy in taxable account (more on this latter).

But what I found out was from a practical point it was PITA to employ this strategy in a IRA. For example on Friday I sell 50 SPY puts @140, next Friday the SPY is at 141 but I can not write SPY 141 next Friday, because I'm short 140 puts and since I can use margin. So I can either buy the puts for a a penny or two in the last few minutes of trading, or wait until Monday to write the new puts. So now I have two days a week I need to watch the market and what if Monday are up days for the market? than I lose vs B&H.

Now lets go back and look at doing the same thing in taxable account. You have plenty of margin available to buy as many contracts as you want with your 700K in cash. But this is the problem all of the profits you generate is taxed a short term cap gains. In contrast if we look at the situation for a B&H investor his is a far more tax efficient strategy. In the last year the SPY has gone from 120 to 140 so the B&H would have 100K in unrealized capital gain. Dividends from the portfolio would about 17K and interest 3K. If his rebalancing date was in Aug. He could sell 200 SPY for $28,000 and would have long term cap gains tax of 45K and ordinary income of only 3,000, he spends 40K and reinvests the rest. I suspect that even if selling puts has a slightly higher total return (as opposed to even) the tax consequences would more than wipe it out.

Not surprisingly Utrecht figured out hey I can have my cake and eat it to. I can still have a portfolio of 5000 SPY etc. and I can also trade the 50 contracts every week, and incur no margin charges, sweet!. However, as Fire51 points out you are taking on more risk, maybe not twice the risk but holding both 5,000 SPY and being short 50 SPY put is significantly more risky than doing just one or the other. The reason it looks like gives superior return is because you are using leverage on an asset class which historically appreciates and incurring no penalty in the form of margin interest.

Overall this doesn't seem like an appropriate strategy for a retiree.

On the hand, in Bernstein latest ebook, The Age of Investor, he specifically recommends that young investor employ margin when they are in the early stages of investing. This seems like one of the least risky ways of doing it.


BTW, Utrecht not surprising we are both serious poker players...

 

[Nords]

With regards to how long doing this stuff takes, I happen to really enjoy it (other than doing the taxes). So saying it just takes too much time is like saying watching football all day long on Sunday is a waste of time. Not if you love football its not. I would be happier if the market was only closed one day per week instead of two. If it ever becomes like work I will stop trading. I used to play what I would call semi pro poker. I played 10-15 hours per week and did very well. Eventually I started to think of it as a part time job and it got monotonous and I quit playing for the most part.

I'm not averse to being undercompensated for taking outsize risks.

I also enjoy working on entertaining projects. But when they turn into drudgery (especially at tax time), then I find myself more focused on the lack of reward compared to the risk. It's a combination of "Why am I working so hard?" and "Why am I taking this risk?"

I still sell naked puts & covered calls. But there are only a half-dozen opportunities per year when I can see the reward being worth the risk (market highs & lows), and the main reason we sell the options is to force us to rebalance our portfolio. Otherwise it'd just turn into more drudgery.

 

[FIRE'd@51]

Since we have been discussing the proper benchmark against which to compare a "naked" put strategy, I would like to suggest one. Since the hedge ratio of a one-week atm put is about -0.5, I think the benchmark should be 50% stock and 50% cash. In other words, compare Utrecht's strategy of selling cash-secured weekly puts on SPY to one-half the return of SPY. While I don't believe Utrecht's strategy will outperform an SPY buy and hold strategy over the long term, I believe it will outperform a 50% SPY / 50% cash strategy.

 

[Stress-Free Retirement]

I have a small $10,000 fun money account that I trade options. Usually iron condors.
But even though I have a bit of real world experience, I've had to "refill" my bucket more than once over the last number of years. I enjoy playing with options and i probably lose less than if I was playing poker with the boys, but for me - OPTIONS are strictly for hedging portfolios or play money -- not serious retirement money (except perhaps for covered calls). Just my 2 cents... mark

 

[sailor]

utrecht - Do you mind updating us on your options portfolio performance?

 

[utrecht]

Ive been selling weekly SPY puts for about 21 months now. That's closing in on 100 trades. I now have enough real time data to have complete confidence in what I'm about to say.

Comparing returns of selling SPY naked puts to the performance of the actual tracking stock itself is tough to do because it depends on how you are doing the comparison. The actual returns have been almost identical which is what the skeptics told me at the beginning so they were correct about that. The thing is though, that when selling options, you have massive leverage. A person can use the margin available to them from their long term holdings to leverage their returns. Obviously this isn't a strategy for the more conservative investor. Its for a trader with a higher risk tolerance.

Since Aug 2011 when I started this, SPY is up a bit over 20%. My return on margin used is about 65%. Over the long term when the market isn't moving up so dramatically the difference between the 2 will be closer to 5x instead of the 3.25X it is now.

Lately, Ive been getting worried about a big pullback so Ive started selling the strike $1 below the current price to give myself a tiny bit of safety.

Edit: the returns I listed are annualized

 

[utrecht]

The last 9 months I've also been trading put calendar spreads. If anyone is interested in discussing them, let me know. I have a total return over the past 9 months of over 100% and the best thing about these trades is it really doesn't matter if the market is going up or down. The spreads do just as well when the market (or more correctly, the individual stocks) are going up or down.

 

[haha]

Utrecht, you clearly are very well informed and proficient at this. Some of it, particularly selling puts on what seems to me to be a high market, would give me the willies. But since you are accustomed to being shot at, what's a few naked option sales?

You could help me with another option related question. I only buy puts or calls, so the risk is nailed down though often the time value can eat me. But I don't do it as an option program, only when I would buy the stock but want the extra bang or limited downside of an option.

My problem is that I do not know very well how to choose strikes or expiration dates. I will never know that something will either happen on Julxx, or not at all. More I will think, but not know, that some stock or more likely ETF is too damn cheap or too expensive, and want a position. Can you suggest a resource or book to give me some guidance at choosing expirations and strikes? So far, on the rare occasions when I do this, I have tended to make some but not huge money, but I confess that I feel pretty much lost which is not a comfortable feeling for me.

Any ideas will be welcome.

Ha

 

[utrecht]

I don't know of any books that discuss which strikes or expirations are best. I'm not sure its possible to write a book like that. I rarely buy options because for the most part they are a losing proposition. Buying options is like swimming up stream. Every day time decay is costing you money. Most people who buy options lose money. I mostly either sell options or buy or sell spreads. The few options I do buy, I call 6/3 options. I buy call options with a strike 10% above the current strike price and buy them 6 months from expiration and sell them 3 months from expiration before any serious time decay starts to kill me. I've had some success with that strategy, but I've never put any serious money into them.

 

[ERD50]

.... I only buy puts or calls, so the risk is nailed down though often the time value can eat me. But I don't do it as an option program, only when I would buy the stock but want the extra bang or limited downside of an option.

My problem is that I do not know very well how to choose strikes or expiration dates. I will never know that something will either happen on Julxx, or not at all. More I will think, but not know, that some stock or more likely ETF is too damn cheap or too expensive, and want a position.
....
Ha

I don't know of any books that discuss which strikes or expirations are best. I'm not sure its possible to write a book like that. ....

FWIW, I agree with utrech. When you buy an option, you do have the premium to overcome ('swimming upstream' is a good analogy). I've done it when I have a gut feel that the market has underestimated a stock in the short term. But I can't quantify that very well, and the longer out you go, the more it will cost you in premium, so the more 'right you need to be, so I try to keep them fairly short. I'm more likely to do it when some bad news has come out, and I think the market has over-reacted, and I expect it to correct somewhat, and do it soon.

Sometimes when I've done that, I've bought fairly deep in the money. The premium is very small, but you can still get a high multiple for leverage. So even a minor correction can be very profitable, %-wise. Of course, you are open to more downside with a lower strike, but if the stock was just beaten down, you may feel that downside is limited, and worth the risk.

It's speculation, you have to take your chances and go contrary to the crowd. I rarely have enough conviction to do it, but occasionally an opportunity seems worth a testosterone play. I know you do a lot of stock analysis, so you might be far better at spotting opportunities.

JMHO - ERD50

 

[haha]

Thanks Utrecht and ERD50 for your comments. I am familiar with the statistics showing that selling options has a much higher probability of success than buying them, But I don't think it follows that it has a higher expectation of profit. Two separate issues. Remember Nassim Taleb- one should troll patiently for unexpected events.

But my specific question has essentially been answered, and this method is more or less the naïve one that I have been practicing. Go out about 6 or so months, buy OTM but not way OTM strikes, and sit patiently for 3 months or so unless something nice happens sooner.

Ha

 

[FIRE'd@51]

Let me preface this by saying that I think utrecht has done a lot of good work and shared his analysis with us. I believe he understands the risks he is taking. Let me add that I think his blog is excellent, as well.

The thing that strikes me is that many of the same folks who ridiculed dixonge's strategy of selling out-of-the-money credit spreads seem not to understand that what utrecht is doing is even more risky, since he is selling ATM puts with leverage and no downside cap on the loss. In any case where dixonge's strategy lost money, utrecht will lose more.

 

[utrecht]

I wanted to post some details on a trading strategy that I call the "5% bracketed put calendar trades". Basically I pick an underlying stock, lets use Mastercard (MA) and lets say its trading at 500. I sell front month ATM puts and buy an equal number of puts that expire the next month. This creates a calendar spread. Since the stock is trading at 500, I use 500 as the strike. The max profit comes if MA trades right at 500 when the front month puts expire. I traded these for several months and did well. The risk comes when the stock rises or falls to far away from the 500 strike. It can move a small amount and be fine but the trade will lose money if it moves to far.

To help with that problem and smooth out the returns, I then added the 5% bracket part of the trade. I add 2 more calendar spreads with the same stock. One with a strike 5% OTM and one 5% ITM. If the stock rises, one trade will profit handsomely but they other will suffer and vice versa. Unless the stock moves 7-8%+, the one trade that profits will normally profit by more than the other one loses.

I have now created a market neutral trade that profits not by stock movement, but from time decay which is a given.

So far, Ive been making these trades on 4 stocks each month to further smooth the volatility that is created when one single stock takes off like a bullet in either direction. Here are the results of the trades from this expiration cycle which ends next week. Other than the obvious risk of several stocks going nuts in either direction, are there any other risks that anyone sees? So far, over about 10 months, I have returns of 137.8% and I am considering increasing my positions sizes.

 

[FIRE'd@51]

utrecht,

Why did you choose to use ITM puts rather than OTM calls for your upper strike part of the bracket?

 

[utrecht]

utrecht,

Why did you choose to use ITM puts rather than OTM calls for your upper strike part of the bracket?

I had already been trading ATM put calendar spreads and had a good feel for how they reacted so I just stayed with puts all the way when I started using the bracketed approach. I have wondered if using all calls or a combination of the two would work better but haven't researched that yet. Do you have an opinion on that?

 

[ERD50]

...
I have now created a market neutral trade that profits not by stock movement, but from time decay which is a given. ...

Well, I'm a simpleton when it comes to this, but how can one expect to profit from something which is a given? Don't the people on the other side of the trade(s) know that time is passing?

emph mine:

... Unless the stock moves 7-8%+, the one trade that profits will normally profit by more than the other one loses.

...

Other than the obvious risk of several stocks going nuts in either direction, are there any other risks that anyone sees?

Again, approaching as a simpleton, I always assume the people on the other side of the trade(s) have done their homework, and know as much or more than I do. And I assume that they have taken the odds of a stock moving 7-8%+, and/or the odds of stocks 'going nuts' into consideration when they priced the trade.

I think the risk is in assuming they haven't.

-ERD50

 

[utrecht]

Time decay is a given. Options decay in value as time passes and the closer the option is to expiration, the faster it decays. Here's a simple example:

You are short June 150 puts on a given stock. You sold them for 1.00 with one month to expiration.
You are long July 150 puts and bought them for 1.75, 2 months from expiration. The trade cost you .75

At the end of June expiration if the stock is still at 150, the June puts expire worthless and the July put you are long are now worth the same 1.00 that the June puts were worth when they were one month from expiration. You made 33% profit. Now there are other factors such as volatility changes, and differences in the number of days in a month, but the main point is shown here which is that the front month options decay faster than the longer dated options. That's what I meant by "time decay is a given".

 

[ERD50]

Time decay is a given. Options decay in value as time passes and the closer the option is to expiration, the faster it decays.

...

That's what I meant by "time decay is a given".

Yes, I know that, and you know that, and presumably the vast majority of the money behind those options is placed by people who know that too.

So my question is, how do you make money on something that everyone knows is going to happen (unless the world ends, and then it is moot)? I'm not a card player, but that sounds like a poker game where everyone shows their cards.

-ERD50

 

[bondi688]

I really messed up with one of recent option trades. When HPQ dropped to $11.38 in Nov 2012, and everyone was really down on the whole PC sector, especially HPQ, I sold 2/13 covered call for HPQ at 16. From 11/12 to 2/13. HPQ went from 11.38 to 18+ with hardly any news. My shares were called away. I thought when they announced the Q1 earning, the share price will drop and I can replace them at 16+ to 17. Well earning and profit continued to drop for Q1 compared to Q4 of 2012 but the loss was less than expected, and the stock price went up to $22. When projection for Q2 was announced, the revenue for every division of HPQ dropped some more, but at a lower rate, the stock price went up to $25 before the recent correction to $23+. It is amazing that a stock can more than double in price when revenue and profit margin keep eroding (HPQ's tablets are not exactly selling like hot cakes and the cloud computing area it went into has not made substantial inroads) and the outlook for the PC sector is still dismal.